Let’s set the record straight on Keystone XL and gas prices

Today, a post has been making the rounds which claims that the Keystone XL pipeline would raise gas prices in the US Midwest by, “20 to 40 cents per gallon, based on the $20 to $30 per barrel discount on Canadian crude oil that Keystone XL developers seek to erase.” Further, the report claims that, “such an increase, just in the Midwest, could cost the U.S. economy $3 billion to $4 billion a year.” Both of these claims deserve to be challenged, since they are not supported by any evidence.

Before I take on these two claims in turn, it’s worth noting that claims about the effect of Keystone XL on gas prices have been floated by proponents of the pipeline as well, such as this piece from TransCanada which states that, “Keystone XL will increase supply to the broader US market – namely the U.S. Gulf Coast. For a given level of demand, higher supply would lower prices for crude oil, which is the most important factor shaping gasoline prices.” What follows applies to those claims as well.

First, let’s be clear – the cost of crude is by far the largest cost for a refinery, and there is no question that Keystone XL will affect crude oil prices in the U.S., leading to more expensive crude in the mid-continent than would otherwise be the case. Since the Gulf Coast market is a coastal market, an increase in supply arriving by pipeline will displace crude which would otherwise enter by tanker, so there’s no reason to expect that Keystone XL would reduce the marginal cost of crude in the Gulf Coast. If, on balance, crude remains cheaper in Alberta, it is possible that some refiners will be able to access crude more cheaply than they otherwise could if they have access to firm shipping space on the pipeline, but this will likely be imperceptible in the data. On a broader scale, the shift in sources of oil supply in North America is likely to shift pricing relationships such that mid-continent crudes remain discounted slightly to coastal crudes for the long term, as marginal barrels flow outward.

So, do lower regional crude costs translate to lower regional gasoline prices? No. In fact, we have had a nice test of this over the last two-plus years as crude costs in the mid-continent have been discounted significantly relative to coastal crudes. As the figure below shows, between January 2004 and mid-2011, Gulf Coast refiners had crude costs slightly lower than their midwestern counterparts, as the marginal barrel was moving in-land from the coast. In mid-2011, everything changed and the mid-continent crude glut led to significantly lower average crude costs for refiners in the midwest.

Given the logic of the Consumer Watchdog report, you would certainly expect that this major transition in relative crude prices would have had an impact on gasoline prices, at least leading to small decreases in the Midwest, right? Well, no. In fact, as shown on the graph below, over the period from January 2011 to today, midwest retail gasoline prices have been, on average, four per cent higher than their Gulf Coast equivalents, while crude costs to refiners were $13.82/bbl lower. In the two years previous, crude costs were less than 1% different on average, and gasoline costs were three per cent higher in the Midwest. A massive crude cost discount had virtually no impact on gasoline prices.

You can guess where this is going. Since the refined product market in the U.S. is not as clearly differentiated by infrastructure as the crude market, the changes in crude costs to midwestern refiners changed their relative position among U.S. refiners, but did not impact the costs of the marginal barrel of refined product. As such, midwestern refiners were able to realize large increases in margins, as shown in the figure below, while consumers were still paying gasoline prices based on the higher cost production in other areas and export market prices.

So, what should we expect to happen to gas prices if Keystone XL goes through? Not much. You would expect to see an increase in crude costs and a decrease in margins for midwestern refiners, and perhaps a slight increase in margins for Gulf Coast refiners. Midwestern refiners will not be able to pass on these costs to consumers because they are already charging market prices for refined product and reaping the benefits of lower cost crude. If they tried to maintain the margins they’ve enjoyed for the past couple of years, they would be priced out of the market. There will be a transfer of wealth, but the transfer will not be from U.S. consumers to oil producers, but rather from U.S. mid-continent refiners to U.S. and Canadian producers, and perhaps a few Gulf Coast refiners as well.

The debate around KXL and gas prices has largely been of the fact-free variety. Let’s focus on the evidence from now on, shall we?

Let’s set the record straight on Keystone XL and gas prices

keystone is all politics as is northern gateway and the west east pipeline. It doesn’t matter the cost to anyone it is largely for the benefit of the feds and their oil pals. I see no benefit or change in gasoline prices since they continue to go up,, regardless of the excuses given I believe that it is all greed mostly from the distributor, since refineries continue to close because they are unprofitable, or at least that’s the story. I note a new pipeline is inching its way across the Midwest through sensitive environmental areas, related to the water table and supply for regions. Fail to understand why these companies ignore the fact that the people they want the oil to be sold to need water to drink not oil

Keystone XL has relatively no impact on gasoline prices in the midwest. US midwest refiners are making windfall profits right now because they get cheap oil in the midwest and are able to sell gasoline at closer to the world price which is set by the cost of refining Brent priced oil on the East coast.

All Keystone will do is reduce the profitability of US midwest refiners, and the oil producers will get a fairer share of the profits, the US refiners less, and the price of gasoline, which is set off of the Brent world price, won’t change much.

Curious about this: “…and the oil producers will get a fairer share of the profits…”

Perhaps I’m reading too much into that statement, but to me it implies that currently oil producers are not getting a fair share of the profits, and that even after KXL, which will make the share fairer, the share still won’t be 100% fair.

What split would be 100% fair? How is the 100% fair value determined or calculated?

Refining oil is essentially a public utility non-profit business. The basic problem with refining is that it has essentially no control over the price it pays for its inputs or the price it receives for its outputs (oil and gasoline and heating oil are some of the most highly traded commodities on the worldwide commodities and futures exchanges). The difference between market set output prices and input costs is called the “crack spread”. Refining is also one of most highly regulated industries. Thus, it is an industry entirely at the mercy of the financial markets and the governments.

A generic refinery is basically an unprofitable business. Refining profitability is entirely a function of geographic competitive advantage where there is an inherent or long term oversupply of oil in the local market and/or an inherent shortage of local refining capacity. Without a geographic competitive advantage that allow a particular refinery to beat the market traded crack spread, any profitibility will be arbitraged away by the producers or the refiners which have the geographic competitive advantage.

Refining is a necessary evil. One does as little refining as possible (to maximize the price of paid for a countries oil) and to ensure there is enough capacity for the local market, given the available supply.

A country or region should have do just enough refining to maximize the price it receives for its finite oil resource, and to minimize the price its consumers have to pay for refined products.

If there is a further geographic competitive advantage, than one can build an export refining capacity as a profitable business.

The oil sands should enable Kitimat/Prince Rupert, and Montreal/New Brunswick to have geographic competitive advantages to build global export refined product industries. Canadian refineries can use international flagged transport to export into the east and west coast US markets, whereas Texas/Lousiana have to US more expensive US flagged tankers to move refined products to the east and west US coasts since currently there is a shortage of refined product pipelines also. The West Coast is also far closer to Asia than Houston/Louisiana, and Montreal/New Brunswick is also closer to Europe than Houston/Lousiana.

So, using economics, how do you explain the divergence that happened in January, 2011? I don’t recall any shut-in production in AB, as one would expect with over supply (looks to me more like cartel behaviour).

And if you can’t explain it, how can you predict what will happen when Keystone is completed? (I’m playing devil’s advocate here, somewhat, not completely)

How are we defining Keystone XL in July 2013? I define it as the portion yet to be approved, as do opponents. And since it will take oil from Hardisty to Steele City where it can connect to a an under capacity line to Cushing, it will raise bitumen prices in Hardisty and lower them in Cushing. The TransCanada statement quoted was dated June 2011 when Keystone XL included the Gulf link so is outdated insofar as price impacts on the coast of this northern leg. Since the Gulf link has been approved and will be transporting oil by the end of the year and will be joined by an expanded Seaway and likely a converted and reversed Trunkline, WTI will closely track the coast price once again. The best hope to moderate that price is to complete the northern leg. Therefore KXL can be expected to lower crude prices in PADD 2. It will have little impact on Alberta gas prices because we refine lighter and synthetic oil.

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